chapter 1 understanding personal finance - test bank & solution … · 2017. 11. 30. ·...

Chapter 1—Understanding Personal Finance

TRUE/FALSE

1. The level of financial literacy is high among Americans today.

ANS: F

financial literacy is low among most Americans.

PTS: 1 DIF: easy REF: p. 4

2. People today face the challenge of saving, investing, and managing their own retirement funds.

ANS: T PTS: 1 DIF: moderate REF: p. 4

3. Personal finance is the study of personal and family resources considered important in achieving

financial success.

ANS: T PTS: 1 DIF: easy REF: p. 4

4. Financial success is marked by having high wealth.

ANS: F

financial success is the achievement of financial aspirations.

PTS: 1 DIF: moderate REF: p. 5

5. By saving and investing, people are much more likely to have funds available for future consumption.


6. One's standard of living comprises all his or her current consumption.

ANS: F

current consumption is one's level of living. Standard of living is what you aspire to achieve.


7. Your standard of living is where you would like to be and your level of living is where you actually

are.


8. You cannot build financial security or wealth unless you spend less than you earn.


9. A business cycle is a pattern of economic activity that includes an expansion, peak, contraction, and

trough.


10. The preferred stage of the economic cycle is the contraction phase.

ANS: F

it is the expansion phase.


11. Since it is impossible to make precise forecasts about economic trends, indicators such as inflation and

interest rates can be ignored when planning your finances.

ANS: F

a reasoned and informed estimate of these indicators can and must be included


12. The typical U.S. recession is marked by an average economic decline of 4 percent.

ANS: F

the average decline has been 2 percent although the most recent has been higher illustrating its

severity.


13. The sum total of all economic activity is measured by the gross domestic product.


14. Procyclical economic indicators are those that predict a positive change in the economy.

ANS: F

procyclical indicators move in the same direction as the economy whether up or down


15. The index of leading economic indicators is a composite index that suggests the future direction of the

U.S. economy.


16. The index of leading economic indicators includes eight components of growth.

ANS: F

it includes 10 components of growth.


17. When the economy begins to show clear signs of a slowdown, it may be a good time to invest in

fixed-interest securities.


18. Leading economic indicators are those that do the best job of measuring the state of the economy at

any point in time.

ANS: F

leading economic indicators help predict how the economy will do in the future.


19. Inflation is defined as a steady rise in the general level of prices.


20. Deflation involves falling prices.


21. Deflation occurs in an economy when their is a contraction in the money supply.

ANS: T PTS: 1 DIF: difficult REF: p. 10

22. In times of moderate to high inflation, people on fixed incomes suffer.


23. Real income and nominal income are two terms that reflect the actual purchasing power of one's

income.

ANS: F

only real income reflects the purchasing power of one's income by incorporating inflation into the

assessment.


24. In times of high inflation, personal incomes generally keep up with the rate of inflation.

ANS: F

when inflation is high real incomes cannot keep up.


25. The consumer price index is a broad measure of changes in the prices of all goods and services

purchased for consumption by urban households.


26. When prices rise, the purchasing power of the dollar declines by the same percentage.

ANS: F

it declines by the reciprocal amount.

PTS: 1 DIF: difficult REF: p. 12

27. Interest is the price of borrowing money.


28. Interest rates on home mortgages and other loans tend to fall during times of high inflation.

ANS: F

interest rates rise as lenders try to compensate for the lower purchasing power of the dollar's with

which they are repaid.


29. All things considered, a saver who earns 6 percent interest on a savings account when the rate of

inflation is 6 percent is losing real purchasing power.

ANS: T

because of the taxes that are assessed on interest income.


30. Smart investors recognize that the degree of inflation risk is higher for long-term lending than for

short-term lending.


31. When forecasting long-term inflation rates for financial planning purposes, it is better to err on the

high side rather than on the low side.

ANS: T PTS: 1 DIF: difficult REF: p. 12

32. Interest rates earned on short-term investments are generally lower than interest rates earned on

longer-term investments.


33. The rate of interest and the inflation rate generally move in opposite directions; when one goes up, the

other goes down.

ANS: F

rates of interest go up and down with the rate of inflation.


34. When one forgoes buying a new television set because he or she spends the money on college books,

the television set is the opportunity cost of buying the books.


35. Opportunity costs are strictly financial in nature and do not involve personal tastes and preferences.

ANS: F

opportunity costs exist in many ways including financial impacts and time.


36. The opportunity cost of a decision is the value of the next best alternative that must be foregone.


37. Marginal cost is the incremental cost of one more incremental unit of something.


38. According to economic theory, people will seek additional utility as long as marginal utility exceeds

marginal cost.


39. Most financially successful taxpayers have to pay federal income taxes at the 15 percent marginal tax

rate.

ANS: F

financially successful taxpayers pay a marginal tax rate at 25% or higher although their average tax

rate is lower.


40. Financially successful people often pay U.S. federal income taxes at the 25 percent, or higher,

marginal tax rate.


41. One's average federal income tax rate is generally higher than one's marginal tax rate.

ANS: F

Average tax rates are lower than marginal tax rates because the marginal tax rate only applies to the

highest segment of income.


42. Tax-sheltered income is preferable to tax-exempt income.

ANS: F

with tax-exempt income taxes are never owed but with tax-sheltered income taxes are usually only

delayed.


43. Tax-exempt income is preferable to tax-sheltered income.


44. Simple interest is the interest computed on principal only, without adding the interest to the principal

to determine future interest.


45. The simple-interest formula assumes that the interest is withdrawn each year.


46. Compounding occurs when earnings are withdrawn from a savings or investment account each period.

ANS: F

to receive compounding of earning, the earnings must be kept in the account to earn future earnings.


47. Compound interest will produce larger investment values than simple interest.


48. Simple interest is always assumed in time value of money calculations.

ANS: F

time value of money calculations always assume compound interest.


49. Compound interest is the calculation of interest on interest as well as on the original investment.


50. Compounding serves as the basis of all time value of money considerations.


51. Future value is the valuation of an asset projected to the end of a particular time period in the future.


52. Present value is also known as discredited value.

ANS: F

present value is referred to as the discount value.


53. Present value is the current value of an asset (or stream of assets) that will be received in the future.


54. The present value of an annuity is the current worth of a stream of payments to be received in the

future.

ANS: T PTS: 1 DIF: easy REF: p. 20-21

55. An employee benefit is compensation for employment that takes the form of wages, salaries,

commissions, or other cash payments.

ANS: F

employee benefits are non-cash compensation such as insurance and retirement plans.


56. Some employee benefits are tax-sheltered, such as flexible spending accounts and retirement plans.


57. A cafeteria plan, also known as a flexible benefit plan, is an employer-sponsored plan that gives the

employee a choice of selecting either cash or one or more qualifying nontaxable benefits.


58. A flexible spending account is an employer-sponsored account that allows employee-paid expenses for

medical or dependent care to be paid with employee's pretax dollars rather than after-tax income.


59. The limits on contributions to an HSA savings account are $3,050 per year for individuals and $6,150

for families.


60. The tax advantage of a flexible spending account (FSA) occurs because the deducted amounts of

salary avoid federal income tax, Social Security taxes, and, in most states, state income taxes, thereby

allowing selected personal expenses to be paid with pretax income.


61. For most employees, their employer's health care plan is their most important employee benefit.


62. Funds in a dependent care FSA account may be used to pay for the care of a dependent as long as he or

she is younger than age 18.

ANS: F

the age of the dependent is not at issue. It is the dependency status.

PTS: 1 DIF: moderate REF: p. 22-23

63. Premiums paid by a worker for disability and long-term care insurance are often more expensive when

purchased through one's employer.

ANS: F

they are usually less expensive; sometimes considerably so, due to the employer’s contributions.


64. Health savings accounts (HSAs) are intended for people who elect a high-deductible health care plan.


65. According to Internal Revenue Service (IRS) regulations, unused contributions to a flexible spending

account are forfeited and are not returned to the employeea condition called the "use it or lose it"

rule.


66. 401(k), 403(b) and 457 plans are example of tax-sheltered retirement plans offered by employers.


67. An advantage of an employer-sponsored tax-sheltered retirement plan is the tax-deferred growth of

contributions and earnings.


68. Retirement planning is a process that should begin three to five years before retirement.

ANS: F

retirement planning should begin as soon as a person becomes financially independent.


69. Interest, dividends, and capital gains from investments in tax-sheltered retirement plans are tax-free.

ANS: F

they are tax-sheltered meaning that the taxes are not assessed as the earnings are accumulated.


70. By law, employers are not permitted to "match" all or part of their employees' contributions, even if

they wish to encourage saving for retirement.

ANS: F

employers are allowed to match employee contributions and many do so and in effect providing free

additional money to employees who themselves contribute into the plan.


71. When faced with a financial problem, you should withdraw money from your retirement plan.

ANS: F

saving over long periods of time is the most effective way to save for retirement and any withdrawals

force one to essentially start over.


72. Fee-based financial planners/brokers charge up-front fees for providing services and charge

commissions on any securities trades or insurance purchases that they conduct on your behalf.


73. A commission-only financial planner/broker charges an up-front fee for providing services.

ANS: F

commission-only financial planners are compensated solely on commissions they receive from the

financial products they sell


74. By law, all financial planners must be Certified Financial Planners (CFPs).

ANS: F

obtaining any type of certification by professionals giving financial advice is strictly voluntary.


75. You would want your financial planner to provide you with an investment policy statement that details

your investment philosophy, your financial situation, and the risks you are willing to take, as well as

what the advisor will do for you.


MULTIPLE CHOICE

76. The study of personal finance includes

a. financial and career planning.

b. risk management.

c. tax planning.

d. all of these.

ANS: D PTS: 1 DIF: easy REF: p. 4

77. Mike and Patty are saving monthly so they can buy a home, but they are currently renting an

apartment. The apartment is part of

a. their standard of living.

b. their level of living.

c. their savings.

d. personal inflation rate.

ANS: B

because it is part of their current financial situation rather than what they aspire to.


78. Financial objectives are rarely achieved without restraining

a. current consumption.

b. savings.

c. investment.

d. future earnings.

ANS: A PTS: 1 DIF: easy REF: p. 5

79. Financial success is defined as the achievement of

a. a financially secure retirement.

b. financial aspirations that are desired, planned, or attempted.

c. vast wealth.

d. a comfortable lifestyle.

ANS: B

not everyone describes success as being wealthy.


80. Which of the following should be the easiest for a person to forecast?

a. Income

b. Inflation

c. Interest rates

d. Economic growth

ANS: A

primarily because the other options are beyond one's personal control.


81. The preferred phase of the economic cycle is

a. expansion.

b. peak.

c. trough.

d. contraction.


82. During expansion, which of the following is high?

a. Unemployment

b. Inflation

c. Interest rates

d. Retail sales

ANS: D PTS: 1 DIF: moderate REF: p. 7

83. The economic phase with conditions making it easy for consumers to buy homes, cars, and other

goods is called

a. expansion.

b. trough.

c. peak.

d. contraction.


84. Interest rates and inflation climb at what phase of the economic cycle?

a. expansion.

b. peak.

c. contraction.

d. trough.

ANS: B PTS: 1 DIF: moderate REF: p. 7

85. Which of the following statements is correct?

a. Long-term interest rates are generally higher than short-term interest rates.

b. Stock market investors are positively affected when inflation rises.

c. The degree of inflation risk is higher for short-term lending.

d. During times of high inflation, interest rates on new loans for cars, homes, and credit cards

fall.

ANS: A

because lenders are less able to make accurate predictions about inflation.


86. The entire business cycle normally takes ____ years.

a. two to three

b. four

c. six

d. ten to twelve

ANS: C PTS: 1 DIF: moderate REF: p. 8

87. A good time to invest in stocks is when the economy is

a. in the prosperity of the expansion stage.

b. in the trough of a recession.

c. in a depression.

d. entering the recovery stage.

ANS: B

as stock prices are lowest at this point and poised for a rebound.


88. The two statistics one should track to understand the future direction of the economy are

a. interest rates and inflation.

b. interest rates and the gross domestic product.

c. the consumer confidence index and the index of leading economic indicators.

d. inflation and the index of leading economic indicators.

ANS: C PTS: 1 DIF: difficult REF: p. 10

89. The statistic that measures the value of all goods and services produced in the United States is the

a. consumer price index.

b. index of leading economic indicators.

c. federal funds rate.

d. gross domestic product.


90. Which of the following economic indicators tends to move in the opposite direction of where the

economy is headed?

a. procyclical indicators

b. employment rate

c. gross domestic product

d. counter cyclical indicators


91. Rick Palmer received a $2,500 raise this year. This increased his salary as an associate TV producer

from $45,000 to $47,500. What percentage increase in nominal income did Rick receive?

a. 2.5 percent

b. 5.3 percent

c. 5.6 percent

d. 7.8 percent

ANS: C

($2,500 / $45,000).


92. Jeremiah and Sara's family income increased from $60,000 to $63,000 in the past year. Inflation was 2

percent over the same time period.Which of the following is true regarding Jeremiah and Sara's

income?

a. Their nominal income increased 4.8 percent.

b. Their nominal income increased 5 percent.

c. Their real income decreased 2 percent.

d. Their real income decreased 5 percent.

ANS: B

$3,000 / $60,000


93. How much is Jeremiah and Sara's real income after the $3,000 increase in income?

a. $63,000

b. $61,765

c. $60,000

d. $58,824

ANS: B

$63,000 / (1.0 + 0.02)


94. If your income increased from $23,000 to $26,000 during a period when the rate of inflation was 4

percent, your real income after the raise was

a. $23,000.

b. $24,000.

c. $25,000.

d. $26,000.

ANS: C

$26,000 / (1 + 0.04)


95. Arvi, a college teaching assistant, received a raise of $650 from $13,000 to $13,650 this year. If

inflation was 2 percent over the same period, which of the following is true?

a. Arvi's increase in real income was $650.

b. Arvi's increase in real income was 7 percent.

c. Arvi's increase in real income was $382.

d. Arvi's increase in real income was 3.3 percent.

ANS: C

($13,650 / 1.02) $13,000


96. The U.S. government measures inflation using

a. the gross domestic product.

b. the index of leading economic indicators.

c. the consumer price index.

d. consumer confidence index.

ANS: C PTS: 1 DIF: easy REF: p. 11

97. If the consumer price index was 199 in 2006 and 212 in 2009, how much did prices increase during

this time period?

a. 6.1 percent

b. 6.5 percent

c. 11 percent

d. 13 percent

ANS: B

(212 199) / 199


98. If the consumer price index was 100 in 1984 and 212 in 2009, how much did prices increase during

this period?

a. 44 percent

b. 56 percent

c. 112 percent

d. 212 percent

ANS: C

(212 100) / 100


99. If the consumer price index was 100 in 1984 and 212 in 2009, the purchasing power of the dollar

a. fell 112 percent.

b. fell 52.8 percent.

c. rose 112 percent.

d. rose 52.8 percent.

ANS: B

1.0 (100 / 212)


100. The rate of increase in prices of items purchased by an individual is called the

a. personal interest rate.

b. rate of inflation.

c. personal inflation rate.

d. consumer price index.


101. A rising inflation rate is good news for

a. stock investors.

b. borrowers.

c. savers.

d. lenders.

ANS: B

as their loans will be paid back with dollars that are worth less.


102. Which of the following is the one key interest rate to focus on when trying to forecast interest rate

trends in the future?

a. Prime rate

b. Federal funds rate

c. Discount rate

d. Mortgage rate


103. Why do rising interest rates generally depress stock prices?

a. Businesses have to pay higher interest rates to borrow money, thus reducing their profits.

b. Stock investors tend to take their money out of the stock market and invest in

interest-paying investments.

c. Future earnings will not be worth as much as today.

d. All of these.

ANS: D PTS: 1 DIF: difficult REF: p. 12

104. Which of the following is an example of a financial opportunity cost?

a. Time

b. Effort

c. Health

d. Interest


105. Lili spent $120 on a new sweater rather than using this money to buy her personal finance textbooks.

The cost of doing without the textbooks is called the ____ cost of buying the sweater.

a. marginal

b. utility

c. opportunity

d. present


106. Bill and Alma are shopping for their first home. They have found two houses that are nearly identical

except for their locations. One house costs $250,000 and is 15 miles from their places of employment.

The second house costs $275,000, but it is within 5 miles of where they both work. Now Bill and

Alma are trying to decide if living 10 miles closer to their workplaces is worth the extra $25,000 in the

cost of the house. Which decision-making concept are they using?

a. Opportunity cost

b. Marginal analysis

c. Time value of money

d. Total utility

ANS: B PTS: 1 DIF: moderate REF: p. 14-15

107. Brice is going to purchase a computer. He has decided on everything except the monitor size. The unit

with the 15-inch monitor costs $1,500 while the unit with the 19-inch monitor costs $1,750. In making

this decision, which concept should Brice use?

a. Marginal utility

b. Time value of money

c. Total utility

d. Marginal tax rates

ANS: A PTS: 1 DIF: moderate REF: p. 14-15

108. Dan just received a $2,000 end-of-year bonus from his employer. If he pays a 25 percent marginal tax

rate for federal income taxes, his state income tax is 5 percent, and the Social Security tax rate is 7.65

percent, approximately how much of the $2,000 bonus will Dan have left to spend on holiday gifts?

a. $2,000

b. $1,400

c. $1,247

d. $753

ANS: C

$2000 x (1.0 .25 .05 .07650)


109. Donald is a college student who has $4,000 in savings that he earned from his summer job. He plans to

leave the $4,000 in a 6 percent certificate of deposit (CD) for three years, but his banker has asked

Donald whether he wants the interest earned on the CD mailed to him at the end of each year or

reinvested in the CD. Approximately how much more will Donald earn if he decides to reinvest the

interest rather than withdrawing the interest income each year?

a. $14

b. $44

c. $144

d. $240

ANS: B

[($4,000 x 1.06 x 1.06 x 1.06) - $4,000] ($4,000 x .06 x 3)


110. Grandmother Smith has just put $12,000 into an investment earning 6 percent a year for her

granddaughter's college education. Approximately how much will be in the account in ten years

assuming all the interest is left in the account?

a. $19,200

b. $21,490

c. $16,320

d. $21,259

ANS: B

$12,000 x 1.7908 from Appendix A.1 or $12,000 x 1.0610


111. Betty and Bill just won $10,000 in the Pennsylvania state lottery. They decide to spend $3,000 now

and put the remaining $7,000 in an investment earning 8 percent compounded annually. If they use the

money in that investment for a vacation in five years, approximately how much will they have

available to spend on that vacation?

a. $14,693

b. $10,342

c. $10,285

d. $9,800

ANS: C


PTS: 1 DIF: difficult REF: p. 17-18

112. Housing values are appreciating at a rate of 3 percent a year. Approximately how much will your

$100,000 house be worth in ten years if this rate of appreciation continues?

a. $134,390

b. $146,320

c. $155,080

d. $174,410

ANS: A



113. Most people save for ____ goals by putting away a series of payments.

a. short-term

b. unachievable

c. long-term

d. tax-free

ANS: C PTS: 1 DIF: easy REF: p. 17

114. Paul invested $10,000 in a security that will double in value in ten years. Approximately what annual

rate of return is this investment making?

a. 10.0 percent

b. 7.2 percent

c. 6.3 percent

d. 5.8 percent

ANS: B

based on the Rule of 72.


115. Over the past few years, the price of houses has been increasing at an annual rate of 4 percent

nationally. How many years will it take for costs to double at this rate?

a. 7

b. 9

c. 15

d. 18

ANS: D

72 / 4


116. Lisa Carson has the opportunity to receive $12,000 now or $15,000 in four years. If Lisa can earn 6

percent on her investments, what is the present value of the $15,000 payment?

a. $15,000

b. $13,785

c. $11,881

d. $9,505

ANS: C

$15,000 x 0.7921 from Appendix A.2 or $15,000 / 1.064


117. ____ is the current value of an asset that will be received in the future.

a. Present value

b. Future value

c. A benefit

d. Inflation


118. The present value of an annuity is the ____ worth of a stream of payments to be received in the future.

a. inflated

b. estimated

c. previous

d. current

ANS: D PTS: 1 DIF: moderate REF: p. 20-21

119. Which form of compensation is not considered an employee benefit?

a. Paid holidays

b. Commissions

c. Health insurance

d. Retirement plan


120. When contemplating taking a job or switching jobs, what should be considered?

a. Comparing salary offers from employers located in cities that have different costs of living

b. Flexible spending accounts

c. Employer-sponsored qualified retirement plans

d. All of these

ANS: D PTS: 1 DIF: moderate REF: p. 21-26

121. Paying expenses with pretax dollars

a. increases taxable income.

b. increases take-home pay.

c. increases after-tax income.

d. is only a good idea for high income earners.


122. A flexible spending account (FSA) is

a. a vehicle that allows employee-paid expenses for medical or dependent care to be paid

with pretax dollars.

b. available through all employers.

c. funded by an employer.

d. taxable income received by the employee if not used by the end of the year.

ANS: A PTS: 1 DIF: moderate REF: p. 22

123. What statement is not accurate regarding participation in an FSA?

a. Funds in a dependent care FSA account may be used to pay only for the care of a

dependent younger than age 21.

b. Unused amounts are forfeited and are not returned to the employee.

c. The maximum annual contribution is $5,000 for a dependent-care FSA.

d. The maximum annual contribution limits are usually $2,000 to $3,000 for a medical-care

FSA.

ANS: A PTS: 1 DIF: moderate REF: p. 22-23

124. What statement is not accurate regarding participation in an HSA?

a. A health savings account is intended for people who have a high-deductible health care

plan.

b. Employees make tax-deductible contributions to their HSAs to be used for eligible

expenses.

c. The employee invests HSA funds and the money in the account grows tax-free.

d. Employers are prohibited from making contributions to their employees' HSA.


125. In an employer-sponsored retirement plan, interest, dividends, and capital gains earned from the funds

invested in the plan are taxed

a. only after funds are withdrawn from the plan, if at all.

b. with each payment.

c. annually.

d. on a quarterly basis.


126. Which of the following is a way to receive free money to deposit into a tax-sheltered retirement plan?

a. Start early to boost your retirement.

b. Take advantage of your employer's "match."

c. Making early withdrawals from a tax-sheltered retirement plan.

d. Opening an HSA.


127. A single person with a monthly taxable income of $7,000 in the 28 percent marginal tax bracket

forgoes consumption and instead places $450 into a tax-sheltered retirement plan every month. What

are the yearly tax savings due to these retirement contributions?

a. $1,120

b. $5,400

c. $1,512

d. $1,316

ANS: C

$5400 x 0.28


128. Which of the following is not an advantage of participating in your employer's retirement plan?

a. Tax-deductible contributions

b. Employer's matching contributions

c. Tax-deferred growth

d. Higher take home pay

ANS: D PTS: 1 DIF: easy REF: p. 23-25

129. Employer-sponsored retirement plans include all of the following except

a. 401(k).

b. 403(b).

c. 457.

d. IRA.

ANS: D PTS: 1 DIF: easy REF: p. 24

130. Which of the following statement(s) is (are) correct?

a. Fee-only planners sell financial products, such as stocks or insurance.

b. Commission-only financial planners/brokers live solely on the commissions they receive

on the financial products (such as investments or insurance) they sell to their clients.

c. Fee-only financial planners may benefit from steering a client to a specific financial

product.

d. From the point of view of the client there is no difference between a fee-only planner and

a commission-only planner

ANS: B PTS: 1 DIF: difficult REF: p. 28

131. If you receive tax-sheltered income, it means that

a. you will never have to pay taxes on the income.

b. the income has already been taxed.

c. the taxes on the income will be deferred until a later date.

d. taxes will be assessed on the state rather than federal leve.


132. During a recession, people and business are likely to engage in ____________; meaning that their use

of credit will decrease.

a. leveraging.

b. deleveraging.

c. compounding.

d. tax-sheltering.


133. Occasionally, the economy will dip into a trough before it has reached a new peak after a previous

trough. This phenomena is called a

a. depression.

b. recession.

c. double-dip recession

d. stagflation.


134. A method by which one can compare cash flows across time, either as what a future cash flow is worth

today (present value) or what an investment made today will be worth in the future (future value) is

called

a. time-value of money

b. compounding

c. simple interest

d. marginal analysis.


chapter 1 understanding personal finance - test bank & solution … · 2017. 11. 30. ·...

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